REPORT TO CONGRESS Macroeconomic and - U.S. Department of the Treasury

[Pages:71]REPORT TO CONGRESS

Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States

U.S. DEPARTMENT OF THE TREASURY OFFICE OF INTERNATIONAL AFFAIRS December 2020

Contents

EXECUTIVE SUMMARY ......................................................................................................................... 1 SECTION 1: GLOBAL ECONOMIC AND EXTERNAL DEVELOPMENTS...................................12

U.S. ECONOMIC TRENDS .................................................................................................................................... 12 ECONOMIC DEVELOPMENTS IN SELECTED MAJOR TRADING PARTNERS...................................................... 24 ENHANCED ANALYSIS UNDER THE 2015 ACT ................................................................................................ 48 SECTION 2: INTENSIFIED EVALUATION OF MAJOR TRADING PARTNERS .......................63 KEY CRITERIA ..................................................................................................................................................... 63 SUMMARY OF FINDINGS ..................................................................................................................................... 67 GLOSSARY OF KEY TERMS IN THE REPORT ...............................................................................69

This Report reviews developments in international economic and exchange rate policies and is submitted pursuant to the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. ? 5305, and Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, 19 U.S.C. ? 4421.1

1 The Treasury Department has consulted with the Board of Governors of the Federal Reserve System and International Monetary Fund management and staff in preparing this Report.

Executive Summary

The global economy experienced a significant negative shock at the beginning of 2020 when the SARS-Cov-2 (COVID-19) pandemic spread throughout the world. Global growth in 2019 slowed to 2.8%, but the impact of the virus led to a deep contraction in the first half of 2020. Governments implemented public health policies and restrictions on mobility to arrest the spread of the virus, and households and business became more cautious in spending and investment decisions. Governments also provided historic economic support to offset the damaging effects of the virus through direct fiscal spending as well as indirect measures. Central banks also took prompt actions to support economic conditions through expansions and extensions of monetary easing as well as policies aimed at stabilizing financial markets.

Global economic conditions have stabilized relative to earlier in the year, but the sharp slowdown in economic activity in the first half of the year indicates that real GDP will decline in 2020. The International Monetary Fund (IMF) forecasts the global economy to contract 4.4% in 2020, the worst recession since the Great Depression. The IMF expects global growth to return in 2021, but the level of GDP in many economies is expected to remain below end-2019 levels in 2021 and beyond. Against this backdrop, it is critical that fiscal and monetary policies in the major economies remain supportive of near-term activity, while structural policies are used to boost medium-to-long-term growth.

With global growth prospects subdued, it is important that governments bolster domesticled growth rather than seek to raise exports and increase contributions from their external sectors. Over the four quarters through June 2020, a number of economies have experienced significant expansions in their current account surpluses, including China, Taiwan, and Vietnam, while other countries, including Germany and Switzerland, have maintained large trade and current account surpluses, which allowed for external asset stock positions to widen further. The total U.S. goods trade deficit widened to 4.5% of GDP in the second quarter of 2020 from 3.6% of GDP in the first quarter. The current account deficit expanded to 3.5% of GDP in the second quarter, 1.4 percentage points larger than in the first quarter and the largest U.S. deficit since the final quarter of 2008. Treasury remains concerned by these persistent and excessive trade and current account imbalances.

Treasury is also concerned by certain economies raising the scale and persistence of foreign exchange intervention to resist appreciation of their currencies. Treasury continues to press other economies to uphold the exchange rate commitments they have made in the G-20, the G-7, and at the IMF. All G-20 members have agreed that strong fundamentals, sound policies, and a resilient international monetary system are essential to the stability of exchange rates, contributing to strong and sustainable growth and investment. G-20 members have also committed to refrain from competitive devaluations and not target exchange rates for competitive purposes. G-7 economies, meanwhile, remain committed to market-determined exchange rates, using domestic tools to meet domestic objectives, and consulting closely and cooperating as appropriate with regards to

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action in foreign exchange markets. IMF members have committed to avoid manipulating exchange rates to gain an unfair competitive advantage over other members.

Nevertheless, a number of countries have conducted foreign exchange market intervention in a persistent, one-sided manner that exceeds Treasury criteria pursuant to the Trade Facilitation and Trade Enforcement Act of 2015 (the "2015 Act"). These actions occurred mostly during a period of dollar weakness as countries sought to limit appreciations of their currencies. Over the four quarters through June 2020, four major U.S. trading partners ? Vietnam, Switzerland, India, and Singapore ? intervened in the foreign exchange market in a sustained, asymmetric manner. Two of these economies ? Vietnam and Switzerland ? exceeded the two other objective criteria established by Treasury to identify potentially unfair currency practices or excessive external imbalances, which could weigh on U.S. growth or harm U.S. workers and firms.

Treasury Analysis Under the 1988 and 2015 Legislation

The Omnibus Trade and Competitiveness Act of 1988 (the "1988 Act") requires the Secretary of the Treasury to provide semiannual reports to Congress on international economic and exchange rate policy. Under Section 3004 of the 1988 Act, the Secretary must:

"consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade."

This determination may encompass analysis of a broad range of factors, including not only trade and current account imbalances and foreign exchange intervention (criteria under the second piece of legislation discussed below), but also currency developments, the design of exchange rate regimes and exchange rate practices, foreign exchange reserve coverage, capital controls, monetary policy, and trade policy actions, as well as foreign exchange activities by quasi-official entities that may be undertaken on behalf of official entities, among other factors.

The 2015 Act calls for the Secretary to monitor the macroeconomic and currency policies of major trading partners and conduct enhanced analysis of and engagement with those partners if they meet certain objective criteria that provide insight into possibly unfair currency practices.

In this Report, Treasury has reviewed 20 major U.S. trading partners with bilateral goods trade with the United States of at least $40 billion annually against the thresholds Treasury has established for these three criteria:

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(1) A significant bilateral trade surplus with the United States is one that is at least $20 billion over a 12-month period.2 This threshold captures a group of trading partners that represented roughly 80% of the value of all trade surpluses with the United States in 2019. It also captures all trading partners with a trade surplus with the United States that is larger than about 0.1% of U.S. GDP.

(2) A material current account surplus is one that is at least 2% of gross domestic product (GDP) over a 12-month period. This threshold captures a group of economies that accounted for about 86% of the nominal value of current account surpluses globally in 2019.

(3) Persistent, one-sided intervention occurs when net purchases of foreign currency are conducted repeatedly, in at least 6 out of 12 months, and these net purchases total at least 2% of an economy's GDP over a 12-month period.3 Looking over the last two decades, this quantitative threshold would capture all significant instances of sustained, asymmetric foreign exchange purchases by major U.S. trading partners.

Treasury's goal in establishing these thresholds is to identify where potentially unfair currency practices or excessive external imbalances that could weigh on U.S. growth or harm U.S. workers and businesses may be emerging.

Because the standards and criteria in the 1988 Act and the 2015 Act are distinct, an economy could be found to meet the standards identified in one of the Acts without being found to have met the standards identified in the other.

Treasury Conclusions Related to Vietnam

Vietnam met all three criteria under the 2015 Act over the four quarters through June 2020. Treasury has conducted enhanced analysis of Vietnam in this Report and will also commence enhanced bilateral engagement with Vietnam in accordance with the Act. The bilateral engagement will include urging the development of a plan with specific policy actions to address the underlying causes of Vietnam's undervaluation of its currency.

Vietnam has tightly managed the value of the dong relative to the dollar at an undervalued level since 2016. Vietnam has applied this policy consistently in periods of both appreciation and depreciation pressure. Additionally, Vietnam entered 2019 with a relatively low level of reserves. Over the four quarters through June 2020, however, Vietnam conducted large-scale and protracted intervention, much more than in previous periods, to prevent appreciation of the dong, in the context of a larger current account

2 The Report covers data from the 12-month period ending in June 2020. Given data limitations, Treasury focuses in this Report on trade in goods, not including services. The United States has a surplus in services trade with many economies in this Report, including China, Japan, Korea, Singapore, and Switzerland. Taking into account services trade would reduce the bilateral trade surplus of these economies with the United States. 3 These quantitative thresholds for the scale and persistence of intervention are considered sufficient on their own to meet this criterion. Other patterns of intervention, with lesser amounts or less frequent interventions, might also meet this criterion depending on the circumstances of the intervention.

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surplus and a growing bilateral trade surplus with the United States. Intervention has also contributed to undervaluation of the dong on a real, trade-weighted basis, with the real effective exchange rate undervalued in 2019. Treasury therefore assesses based on a range of evidence and circumstances that at least part of Vietnam's exchange rate management over the four quarters through June 2020, and particularly its intervention, was for purposes of preventing effective balance of payments adjustments and gaining unfair competitive advantage in international trade. Hence, Treasury has determined under the 1988 Act that Vietnam is a currency manipulator. Consistent with the 1988 Act, in the context of forthcoming negotiations with the Vietnamese authorities, Treasury will press for the adoption of policies that will permit effective balance of payments adjustments and eliminate the unfair advantage created by Vietnam's actions.

? Vietnam enacted a prompt, aggressive response to the COVID-19 outbreak, including closing the northern border with China in January, banning flights starting in February, and imposing a nationwide lockdown. These actions helped contain the outbreak, though the pandemic and public health response have weighed heavily on growth. The authorities enacted countercyclical fiscal measures totaling approximately 3.6% of GDP, which included cash transfers, tax deferrals, and a cut in the corporate income tax rate for small and medium enterprises (SMEs). The effectiveness of Vietnam's initial public health response enabled the government to loosen many of the restrictions on domestic activity, facilitating a bounce-back in the third quarter of 2020.

Vietnam's trade surplus continued to expand year-over-year in the first half of 2020, helping push the current account surplus over the four quarters through June 2020 to 4.6% of GDP.4 Over the same period, Vietnam's goods trade surplus with the United States reached $58 billion, the fourth largest among the United States' trading partners. The Vietnamese authorities have conveyed credibly to Treasury that net purchases of foreign exchange in the four quarters through June 2020 were $16.8 billion, equivalent to 5.1% of GDP. The majority of these purchases occurred in the second half of 2019, prior to the onset of the COVID-19 pandemic.

Vietnam should move expeditiously to strengthen its monetary policy framework to facilitate greater movement in the exchange rate to reflect economic fundamentals, while reducing intervention and allowing for the appreciation of the real effective exchange rate. Vietnam should also increase the transparency of foreign exchange intervention and reserve holdings.

Vietnam should also work to durably reduce its external imbalances and strengthen domestic demand by leveling the playing field for the domestic private sector through measures such as improving its access to land and credit, reducing the role of state-owned enterprises in the economy, and improving financial supervision to

4 Vietnam is in the process of revising its GDP figures, resulting in significant revisions to GDP levels. However, quarterly revised figures are not available. In this Report, we estimate a revised series of quarterly GDP based on the degree of revisions to the annual figures used when calculating current account balances and foreign exchange intervention as a share of GDP.

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help facilitate more productive lending and spur private domestic investment. Vietnam also needs to dismantle barriers to U.S. companies and U.S. exports in Vietnam to reduce the bilateral trade imbalance.

Treasury Conclusions Related to Switzerland

Switzerland met all three criteria under the 2015 Act over the four quarters through June 2020. Treasury has conducted enhanced analysis of Switzerland in this Report and will also commence enhanced bilateral engagement with Switzerland in accordance with the Act. The bilateral engagement will include urging the development of a plan with specific policy actions to address the underlying causes of Switzerland's external imbalances.

The Swiss franc has long been considered a safe haven currency that investors acquire during periods when global risk appetite recedes or financial volatility accelerates. These large safe haven flows pose challenges for Swiss macroeconomic policymakers, particularly in a period of negative interest rates and deflation. The Swiss National Bank (SNB) over the years has employed a range of tools to try to offset appreciation pressure on the franc and limit any associated negative impacts on inflation and domestic growth. Over the second half of 2019 and particularly in the first six months of 2020, Switzerland conducted largescale one-sided intervention, significantly larger than in previous periods, to resist appreciation of the franc and reduce risks of deflation, as the SNB's policy interest rates were significantly negative. While we recognize the extraordinary financial volatility in the first half of 2020 resulting from the COVID-19 crisis, the intervention was taken in the context of an extremely large current account surplus along with a growing bilateral trade surplus with the United States and contributed to stemming the appreciation of the franc on a real, trade-weighted basis. Further franc appreciation would help facilitate gradual adjustment of Switzerland's excessive current account surplus. Treasury therefore assesses, based on a range of evidence and circumstances, that at least part of Switzerland's exchange rate management over the four quarters through June 2020, and particularly its foreign exchange intervention, was for purposes of preventing effective balance of payments adjustments. Hence, Treasury has determined under the 1988 Act that Switzerland is a currency manipulator. In the context of forthcoming negotiations with the Swiss authorities, Treasury will press for the adoption of policies that will permit effective balance of payments adjustments.

? Switzerland was one of the countries in Europe hit early and hard by COVID-19, leading the government to declare a national state of emergency in mid-March. The number of active and new cases declined sharply from mid-to-late April but started rising again from mid-June as the authorities eased public health and mobility restrictions. Since mid-October, the number of new COVID-19 cases has surged, with new infections significantly above spring 2020 highs, leading the Swiss Federal Council to re-introduce several containment measures.

Switzerland has for many years run extremely large current account surpluses, with the surplus reaching 10.9% of GDP in 2019. The current account surplus declined marginally, but remained elevated, at 8.8% of GDP over the four quarters through

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June 2020. The United States' goods trade deficit with Switzerland widened notably over the last year, reaching $49 billion over the four quarters through June 2020, due partially to an increase in Swiss gold exports in the first half of 2020. The SNB disclosed that it spent $93 billion (90 billion francs) on currency interventions in the first half of 2020. Between July 2019 and June 2020, Treasury estimates that SNB net foreign purchases have totaled $103 billion (or 14% of GDP).

Switzerland should employ a more balanced macroeconomic policy mix. Monetary policy continues to be relied on heavily despite the reduced effectiveness of unconventional tools, especially against a backdrop of persistent deflationary risks. We urge the SNB to deploy a broader and more balanced mix of monetary policy instruments, including domestic quantitative easing. Central to this recommended recalibration of monetary policy, we continue to urge the SNB to limit foreign exchange intervention to lean against large appreciation surges and allow real appreciation in line with the long-term trend. Treasury welcomes the SNB's recent step to disclose foreign exchange intervention on a quarterly basis. Increased frequency of these disclosures ? such as on a monthly basis ? will help further improve transparency of the SNB's actions. Fiscal policy should be deployed to reduce the economy's reliance on the SNB's policy measures, rebalance its external sector, and boost potential growth. The authorities should also take steps to raise potential growth by raising labor force participation rates and productivity growth, actions that would reduce Switzerland's external imbalances and reliance on unconventional monetary policy.

Treasury Assessments of Other Major Trading Partners

Pursuant to the 2015 Act, Treasury has found in this Report that no major trading partner other than Vietnam and Switzerland met all three criteria during the four quarters ending June 2020. Treasury has also concluded that no major trading partner of the United States other than Vietnam and Switzerland met the standards identified in Section 3004 of the 1988 Act during the relevant period.

Regarding the 2015 Act, Treasury has established a Monitoring List of major trading partners that merit close attention to their currency practices and macroeconomic policies. An economy meeting two of the three criteria in the 2015 Act is placed on the Monitoring List. Once on the Monitoring List, an economy will remain there for at least two consecutive Reports to help ensure that any improvement in performance versus the criteria is durable and is not due to temporary factors. As a further measure, the Administration will add and retain on the Monitoring List any major U.S. trading partner that accounts for a large and disproportionate share of the overall U.S. trade deficit even if that economy has not met two of the three criteria from the 2015 Act. In this Report, the Monitoring List comprises China, Japan, Korea, Germany, Italy, Singapore, Malaysia, Taiwan, Thailand, and India, the last three being added in this Report.

Ireland has been removed from the Monitoring List in this Report, having met only one out of three criteria ? a significant bilateral surplus with the United States ? for two consecutive

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